The Office of the Superintendent of Financial Institutions Wednesday published a draft guideline that sets out the regulator’s expectations for the use of stress testing by federally regulated financial institutions.

In a statement accompanying the guideline, OSFI notes that the global financial crisis revealed that existing stress testing procedures were inadequate. “Events in financial markets during the last two years have highlighted the importance of rigorous and actionable stress testing programmes. Experience has shown that stress testing did not always include events considered to be unlikely or extreme, or events for which no historical data exists, it says.

OSFI, and other financial industry regulators, found that many financial institutions, “need to improve their stress testing programmes with respect to timeliness, identifying the interaction of risks and severity of stresses chosen.”

As a result, OSFI is seeking to establish, “a standard against which stress testing programs can be evaluated and to ensure the principles apply equally to all regulated financial institutions.”

The guideline will affect stress testing practices at banks and insurance companies. “Given that, broadly, the same principles and standards for stress testing apply to both the deposit taking and insurance sectors, and OSFI’s desire to have common guidance for all sectors where appropriate, OSFI is of the view that the creation of common guidance is the most appropriate option for ensuring sufficiently robust guidance is available to financial institutions,” it said.

The draft guideline is also being issued for comment for six weeks. OSFI expects to implement the guideline in late 2009.

IE